‘Short Volatility’ Trade Looking Ever Riskier

By Brendan Conway

Investors who see the downward path of various hedges against market volatility might get an idea: Take the other side of the trade. Get paid for the worry baked into stock prices since the financial crisis.

The reality is the trade for volatility “roll yield,” as it’s called, is a reenactment of the old Wall Street line about picking up pennies in front of a steamroller. Works great until you get crushed.

The next drop in U.S. equities may spur a bigger jump in the Chicago Board Options Exchange Volatility Index as investors rush to cover their record bets against the gauge, according to Societe Generale SA.

Hedge funds and other large speculators have more than doubled short positions on VIX futures to 189,020 contracts since the end of June, according to data compiled by the U.S. Commodity Futures Trading Commission. The wagers reached a record last month. The current figure implies those investors may lose $99.5 million with every 1 point increase in the volatility gauge, CFTC data show.

This year’s rally in U.S. stocks has led to a 19 percent plunge in the VIX, creating profitable strategies to bet against volatility futures. A decline in equities and subsequent increase in share-price swings would bring losses for VIX short sellers, which may drive them to cover the trades, according to Ramon Verastegui of Societe Generale. Increased demand for the contracts will push volatility higher and may exacerbate the stock-market selloff, he said.

If nothing bad happens in the stock market, this trade works in the same way that its opposite numbers, Barclays iPath S&P 500 VIX Short-Term Futures ETN (VXX) and the leveraged ProShares Ultra VIX Short-Term Futures ETF (UVXY) and VelocityShares Daily 2X VIX Short Term ETN (TVIX), don’t.

Then the music stops and you’re left without a chair. See the July and August 2011 chart for XIV.

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There are 7 comments

SEPTEMBER 18, 2013 12:00 P.M.

Adam wrote:

I would LOVE a repeat of July/August 2011. That would result in about $100,000 in earnings right now

SEPTEMBER 18, 2013 12:19 P.M.

Ralph wrote:

You point to a black swan event that happened 2 years ago.

For those who had positions in XIV prior to this event, all they had to do was hold the position and they would be up about 35% higher than when the black swan event happened.(35% return in 2 years would be a great return for most investors!!!)

All investors who purchased VIX or SVXY (or shorted UVXY) since that black swan event would have made alot more money (then the pennies you are outlining).

Key is to not just hold indefinetely as sooner or later a black swan event will happen. Until it does, keep picking up this money, but either limit your purchases or perhaps buy insurance (UVXY leaps are an alternative).

SEPTEMBER 18, 2013 1:31 P.M.

velocity2012 wrote:

Let's see ... about a 30,000 percent move UP in volatility should bring TVIX holders back to about a 10% loss after the Reverse Splits, provide TVIX does not decouple from tracking the S&P Future Volatility Index ... oh never-mind, forgot they changed the Offering Document to DECOUPLE when ANY EXPOSURE IS PRECEIVED.

SEPTEMBER 18, 2013 3:43 P.M.

Hammer wrote:

I'm sensing a sickness here.

SEPTEMBER 19, 2013 9:08 A.M.

Rose wrote:

I can't believe such a shallow article could have made its way to the Barron's.
The author failed to mentioned the "roll yield" was about 7 to 10% per month, which were much more than pennies for any investor other than loan sharks.
Also not mentioned was the fact the big drops in SVXY pps were recovered within a few months.

SEPTEMBER 19, 2013 12:49 P.M.

velocity2012 wrote:

Any news on the next Reverse Split since TVIX has lost nearly HALF its price in the last 13 trading days or since the last Reverse Split Aug 30th?

SEPTEMBER 19, 2013 3:51 P.M.

Anonymous wrote:

i agree with ralph, if you were picking up pennies, you only get steam rolled if it goes to zero (which isn't possible).

You see that is a good analogy for a real business or investor where you permanently impair capital. In this case it is like taxes, you simply are deferring the gain. So if you are an investor with a constantly growing capital base and you implement this trade and then 2011 happens you should have more capital available for the trade.

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